Although crude prices have risen in 2012, it was mainly due to its strained supply. But according to International Energy Administration, global demand for crude will increase by 840,000 barrels per day in 2013. High crude prices are good for oil E&P companies, but its higher demand benefits oil refining companies.
Moreover, natural gas is used as an ingredient in crude refining, and lower natural gas prices adds to the margins of oil refining companies. To their delight, natural gas futures recently plunged to their 5 week lows due to high inventory levels, and weather forecasts hinting towards warmer-than-normal temperatures in February. This is double delight for oil refining companies, and I believe that investors should load up on companies like HollyFrontier Corp (NYSE:HFC), Tesoro Corporation (NYSE:TSO) and Marathon Oil Corporation (NYSE:MRO).
HollyFrontier is one of the largest independent oil refiners in the US, with a refining capacity of 443,000 barrels. Recently its management announced that it would be expanding its Woods Cross refinery, to ramp up its refining capacity by 13.85% (or 60,000 barrels per day). Its Q3 throughput stood at 433,000 bpd on a capacity of 443,000 bpd, which shows that its refineries were operating at nearly 98% of their capacity. This expansion would not only allow a higher throughput, but would also reduce the workload in each of its refineries. It’s called spreading the risks.
As of Sept. 30,its total cash balance including marketable securities totaled $2.3 billion, which rose by 43.5% on a quarterly sequential basis. Its LT debt/equity and debt/capital equate to just 23% and 18%, respectively, which suggests that the company has no debt problems whatsoever. To be precise, its total debt stood at just $471.8 million (excluding non-recourse HEP debt).
On quarterly basis, the company reported an impressive 9% growth in gross margin per barrel (above $30/barrel). As a result, its EBITDA also jumped from $895 million to $1 billion. During the earnings call, its board bumped its regular dividend by 33%, but yesterday its regular dividend was boosted by 50%. This the 5th dividend hike over the last 2 years and at the CMP, its yield equates to 2.2%. Additionally, the board also approved a special dividend of $0.50 per share, and its payout ratio stands at 48%, which is well within acceptable limits.
How do the Competitors Fare?
HollyFrontier shares its market space with Tesoro Corporation and Marathon Oil.
| Company | Forward P/E | Gross Margin | Debt/Equity | Yield |
| HollyFrontier | 7.77x | 19.53% | 23% | 2.2% |
| Marathon Oil | 10.74x | 37.44% | 36% | 1.98% |
| Tesoro Corporation | 8.65x | 12.05% | 33.5% | 1.5% |
On taking a look at the metrics, all three companies appear to be undervalued. Although Tesoro Corporation has lower margins, I think it’s a value play here. For the recent quarter, its gross margin per barrel rose from $6.02 to $14.25, which is a massive 137% increase. Its management said that it continues to benefit from the less expensive Canadian and domestic crude. The management also added that it is searching for ways to bring more Canadian crude to its West Coast refinery, via rail or by road. This means that its margins would continue to head north in the coming months.
